Mixed signals on housing but adjustment process seems likely to have further to run: Bill Evans

Mixed signals on housing but adjustment process seems likely to have further to run: Bill Evans
Mixed signals on housing but adjustment process seems likely to have further to run: Bill Evans

The Westpac Melbourne Institute Index of Consumer Sentiment rose 2.8% to 104.3 in November from 101.5 in October.

That was a surprisingly strong result. In particular, respondents are much more positive about their own finances. That is despite consistent reports around weakness in the housing markets in the major capitals and the sharp falls in the equity market through October.

Low interest rates and their prospect of being sustained for some time are clearly supporting confidence.

For example, the confidence of those respondents with a mortgage increased by 4.3%. However, on a more cautionary note, measures of spending intentions have been weaker.

Consumer views around housing were very interesting. Buyer sentiment improved sharply but price expectations fell to new lows.

The ‘time to buy a dwelling’ index posted a strong 11.8% surge to be up 16.7% on a year ago to the highest level since March 2015.

Consumers in NSW showed a particularly strong gain with a 26% jump taking the state index to a five year high and suggesting the decline in Sydney house prices is starting to generate some interest from buyers.

Because the NSW Index has been so low, this stunning improvement only restores the Index to just below its long term average.

The other state, Victoria, where prices have recently shown significant weakness, improved only modestly with “Time to Buy” up only 3.3%.

Consumer expectations for house prices posted another fall in November.

The Westpac Melbourne Institute Index of House Price Expectations fell 2.3% to 99 – on par with the weakest read we have ever seen on this index, when it was first compiled back in May 2009.

The state detail continues to show particularly weak reads in NSW and Victoria, both hitting new lows in November with Victoria’s index down 25% over the last three months alone.

The house price corrections underway in Sydney and Melbourne now look to be firmly embedded in consumer expectations.

In this cycle, Sydney dwelling prices have already fallen by 8.7% while prices in Melbourne are down by 5.1%.

New lending for housing is also contracting. New lending for “upgraders” (owner occupiers excluding First Home Buyers) has fallen by 13.2% over the last year (October 2017 to September 2018) but more significantly has fallen by 10.7% in the two months to September.

New lending to investors peaked in December 2016 and has fallen by 25.9% in the year to September 2018 and 4% over the last two months.

These developments have largely reflected stretched affordability (on the demand side) in the two cities and tighter lending policies from the four major banks (on the supply side).

Households now expect house prices to continue to fall. The Westpac Melbourne Institute Index of House Price Expectations has fallen by 39% for NSW and 41.5% for Victoria over the last year.

Both indexes moved from prints which indicated that optimists strongly outnumbered pessimists (134 for NSW and 144 for Victoria) to positions where pessimists outnumber optimists (82 for NSW and 84 for Victoria).

Note that any read below 100 indicates a majority of pessimists.

Furthermore these current levels are the lowest we have registered since Westpac and the Melbourne Institute first started this question in the Consumer Sentiment survey in May 2009.

Westpac also calculates measures of housing affordability. These relate to the proportion of income required to accumulate a deposit and service a loan which is 75% of the median house price. These measures of affordability can vary around assumptions related to the time required to accumulate the deposit and whether the 75% is a reasonable assumption.

Based on the estimates being used we assess that affordability in both NSW and Victoria is more stretched than we saw in the previous periods which preceded falls in house prices – 2008/09 and 2010/11.

Peak to trough in those previous periods were falls of 6.4% (Sydney) and 8.7% (Melbourne) in 2008/2009 and 3.4% (Sydney) and 8.2% (Melbourne) in 2010/2012.

The restoration of affordability in those previous periods came through falls in interest rates and house prices while income growth also contributed. Wages growth was running at around 4% in both periods. That compares with current wages growth of 2.3%.

In the 2008/09 period the RBA cut the cash rate by 425 basis points from 7.25% to 3%; in the 2011/12 period it cut rates.

by 175 basis points from 4.75% to 3.00%. The challenge with this particular cycle is that the RBA appears to be absolutely committed to the next move in rates being up.

So in those previous periods affordability and demand were restored through a combination of income growth; substantial rate cuts; and price adjustments. In this current period the responsibility for a restoration of affordability will fall mainly to price adjustments.

The Consumer Sentiment Report indicated that the “Time to Buy a Dwelling” Index had lifted significantly in the weak NSW market.

That might imply that despite continuing stretched affordability, prospective buyers may be considering re-entering the market. That does seem surprising given the downbeat price expectations and stretched affordability.

However, as discussed, in this cycle there is another complication.

We have a different environment from the perspective of credit supply. Banks have tightened credit conditions such that when demand for credit recovers (as may be implied by the “Time to Buy” index for NSW) it may not be as simply accommodated as was the case in those previous periods.

This will complicate the usual adjustment process. Markets stabilise when prospective buyers feel encouraged to re-enter the market. Affordability returning to equilibrium and price expectations turning positive are generally the triggers for markets to recover.

The “Time to Buy” index for NSW is sending an encouraging early signal but if prospective buyers are unable to secure adequate funding to enter the market, the move to the new equilibrium may be more extended.

In summary it is apparent that this cycle is quite different to the two previous down cycles for dwelling prices. Affordability is more stretched and sources of adjustment are more restricted.

Furthermore, credit conditions indicate that a recovery in affordability and demand may not be accommodated through credit supply in the same way we saw in previous cycles.

BILL EVANS is chief economist of Westpac.

Dwelling Prices Consumer Sentiment

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